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Franchise Law Update

Commentary on Business and Legal Issues of Franchising

Antiquated Regulations Hobble Growth of Franchises in Food Truck Industry

Posted in Articles, Business Updates, Start-Up and Emerging Franchisors

The food truck industry is still hot and doesn’t appear to be slowing down.  The Four Seasons (yes, that Four Seasons) just recently begun a 9 city tour with its food truck offering its own upscale Philadelphia inspired menu including a “Victory Root Beer Phloat” with Tastycake Butterscotch Krimpet Ice Cream for dessert.   But is this continued craze translating to more food truck franchises?The Philadelphia Business Journal recently published an interesting article about the hurdles food trucks face in the city of Philadelphia.  The article delves into two big issues facing food trucks.  First, that city and county’s vending laws are often antiquated and fail to property represent today’s gourmet food truck movement.  Often the definition of a “mobile vendor” under these laws does not represent how modern food trucks operate resulting in onerous restrictions on where and when trucks may operate.   Or, in the case of the city of Houston, food trucks operating in the city cannot use industry standard propane and must operate within 500 feet of a flushable toilet.

Second, food trucks are facing competition from established brick and mortar restaurants using food trucks to give away free samples as part of marketing and advertising campaigns which can put an obvious cramp on businesses looking for paying customers.

My thoughts turned to franchising and whether there are many franchise systems out there having success with the food truck model.   The answer, for the time being, appears to be no.   Eric Silverstein, owner and operator of the Peach Tortilla food truck concept in Austin, Texas, wrote an interesting blog on food truck franchising last year.  He figured that lower start-up costs, the limited menu and easy to replicate concepts should work in favor of franchising.  However, like the Philadelphia Business Journal he also cites changing and non-uniform city laws as a major impediment to any serious growth in food truck franchising.

This is not to say that concepts are not trying. Many existing brands are having success adding trucks or mobile units as an additional option to prospective franchisees.  Franchise Hudson’s Coffee recently added a mobile food truck to its franchise offerings.   Although again, many of these brands use company owned food trucks initially only as a way to test markets and promote their brands.  There are not too many success stories of start-up concepts utilizing a purely mobile unit option.  However, this may change as outdated local laws are modernized to make it easier for food trucks to operate.  For now it appears that unclear laws and other factors will continue to thwart any significant growth of new mobile truck concepts.

Exorcise Your Cyber Demons (yeah, it’s National Cyber Security Awareness Month again)

Posted in Business Updates

It is October. And, while it is time for fall foliage–did you know Pennsylvania has 134 native tree species to New England’s 70?–ghosts, goblins and Halloween, the Federal Trade Commission reminds us that it is also time for National Cyber Security Awareness Month.

A lack of adequate cyber security measures for your business or home may in fact be scarier than a midnight showing of The Exorcist.

But there are a number of simple steps you can take this weekend to help keep your online life secure:

  1. Use security software–and keep it up to date. Threats change regularly.
  2. Keep your operating system and web browser up to date. This can be difficult, as IT departments worry about non-compliant software issues. But failing to update system and browsing software leaves “holes” for hackers.
  3. Create strong, long and unique passwords. Can’t remember them? Consider one of the many password managers available.

These small steps are the first steps to busting cyber crime.

Unknown Standards of Materiality Lead Governor Brown to Veto SB 610

Posted in Legislative Updates

In a follow up to our post on August 25, 2014, Governor Brown of California has vetoed SB 610, a bill which among other things would have made it considerably more difficult for franchisors to terminate franchisees in California and ended a franchisor’s right to approve certain franchisee transfers of their business. In his veto message, the Governor stated that “The bill’s changes would significantly impact California’s vast franchise industry”. His message states that he “needs a better explanation of the scope of the problem so I am certain that the solution crafted will fix those problems and not create new ones.” The Governor also noted that “the parties supporting and opposing this bill have dramatically different views” and that “it is in the interest of all that a concerted effort be made to reach a more collaborative solution.”

For the lawyers in our audience, Governor Brown’s veto message mentions in particular that the new standards of materiality (“substantial and material breach”) in the bill are unknown and the “good cause” standard is well-understood as a legal standard – indicating a potential concern that approval of this bill would produce additional litigation – a complaint voiced frequently by the International Franchise Association and others.  We agree with the Governor that this bill has always seemed to be a solution in search of a problem, and applaud his suggestion that all parties involved go back to the bargaining table and commit themselves to working toward a mutually amicable solution.

 

Commissions Are Not Franchise Fees under Illinois Franchise Act

Posted in Legal Decisions

The United States District Court for the Southern District of Illinois recently ruled that the Illinois Franchise Disclosure Act (IFDA) did not apply to a contract between a company, Accounting Practices Sales, Inc. (APS), and a broker where the broker was only required to pay APS a percentage of each commission received.

To constitute a “franchise” under the IFDA the person granted the right to engage in the business must pay the franchisor a direct or indirect fee of $500 or more.   The District Court ruled that the broker was not required to pay anything to APS outright and the commission payments could not be considered an indirect franchise fee because the amount was not guaranteed and could have conceivably amounted to nothing at all.

This is important guidance for businesses attempting to navigate state and federal franchise laws.   I counsel many clients who enter into business arrangements that would be considered a franchise but for the non-payment of a “guaranteed” fee.    The rule, at least in Illinois, appears to be that if the payment is indefinite, contingent on certain events, or not mandatory then a franchise does not exist and the IFDA will not apply.

Guidance for Disclosing Multi-Unit Franchising Arrangements

Posted in Regulatory Compliance

Contributed by Alexander S. Radus

As part of its recent 2014 Annual Conference, the North American Securities Administrator’s Association, Inc. (“NASAA”) formally adopted the Franchise Multi-Unit Commentary (the “Commentary”). The Commentary provides practical guidance for disclosing multi-unit franchising arrangements, which the NASAA and Federal Trade Commission had not previously addressed.  The date of adoption by NASAA was September 16, 2014 (the “Adoption Date”). Depending on the franchisor’s or subfranchisor’s status, the Commentary becomes effective on different dates:

  1. For franchisors or subfranchisors that do not have effective FDDs as of the Adoption Date, the Commentary becomes effective 180 days from the Adoption Date. Franchisors filing FDDs in registration states should be complying with the Commentary’s guidance by the spring of 2015.
  2. For franchisors or subfranchisors that do already have effective FDDs as of the Adoption Date, the Commentary becomes effective 120 days after the franchisor’s or subfranchisor’s next fiscal year end.

The Commentary provides disclosure guidance for three multi-unit franchising structures that currently have no universal terms in the franchise industry. The Commentary adopts three common terms to describe these structures. The Commentary recommends franchisors use these terms to facilitate state administrators’ review of FDDs.

Area Development

  • Definition: A person (an “area developer”) who is granted, for consideration paid to the franchisor, the right to open and operate multiple unit franchises.
  • Governing Agreement: Area development agreement.
  • Common Terms:  Delineates territory in which the area developer can open and operate franchises, specifies the number of units to be developed and a development schedule.

Subfranchise Rights

  • Definition: A person (a “subfranchisor”) who is granted, for consideration paid to the franchisor, rights related to granting unit franchises to third parties.
  • Governing Agreement: Subfranchisor agreement (aka master franchise agreement). The subfranchisor–franchisee relationship is governed by a “subfranchisee agreement.”
  • Common Terms: Specifies a territory in which the subfranchisor may operate, a minimum opening schedule, and often obligates the subfranchisor to provide support services to franchisees.

Area Representation

  • Definition: A person (an “area representative”) who is granted, for consideration paid to the franchisor, the right to solicit or recruit third parties to enter into unit franchise agreements with the franchisor, and/or to provide support services to such third parties.
  • Governing Agreement: Area representative agreement. The area representative–unit franchisee relationship is governed by a “unit franchise agreement.”
  • Common Terms: The area representative typically receives portions of the initial franchise fees and the continuing fees paid by unit franchisees.
  • State law considerations: Some states’ franchise laws may consider an area representative to be a subfranchisor if it provides support services to third parties with unit franchise agreements. State laws differ whether an area representative must register as a subfranchisor with state franchise authorities.

Despite the NASAA Commentary’s guidance, franchisors should check with state franchise regulatory authorities for conflicting interpretations. If a state franchise regulatory authority defines or specifically interprets a multi-unit arrangement differently from the Commentary, the state’s interpretation controls.

 

 

 

 

In Wake of McDonald’s, GOP Senate Proposes Bill to Restructure National Labor Relations Board

Posted in Legislative Updates

A new bill was introduced by Senate Republicans this week which aims to reform the structure of the National Labor Relations Board (NLRB).  Among other changes, the bill, called the NLRB Reform Act, would require the NLRB to have 6 board members of which 3 must be Republicans and 3 must be Democrats–similar to the make-up of the Federal Election Commission.   Currently the NLRB is comprised of 5 members (and, while the split is currently 3 Democrats and 2 Republicans, members are appointed by the President to five year terms upon the consent of the Senate).   In addition to changing the composition of the board, the NLRB Reform Bill would cut the budget of the NLRB if the board is not able to decide 90 percent of its cases within a year and expedite the process by which a party can appeal a NLRB General Counsel complaint to the Federal Courts. Notice, too, that this bill would eliminate the possibility of independent representation on the NLRB.

The NLRB has received a lot of press of late – both positive and negative – since its General Counsel opined that McDonald’s can be a joint employer with its franchisees this past summer. Opponents of the bill claim that an even split of board members along partisan lines would render the NLRB in constant gridlock and therefore useless at resolving important labor cases.  Proponents of the bill, including the International Franchise Association, claim that the bill is necessary to eliminate and change the NLRB “from an advocate to an empire.”  It is unlikely that the NLRB Reform Act will move forward given the Senate’s current composition but we be watching for any developments especially if the next election changes the Democratically controlled Senate.

Franchisor Is Not the Employer of Franchisee’s Employee under the FLSA, so says the Fifth Circuit Court of Appeals

Posted in Legal Decisions

Contributed by Christina Stoneburner

Plaintiffs have recently been stretching the limits of who is their employer for purposes of protection under state and federal employment laws.  We recently reported about a case against 7-Eleven where the Court refused to dismiss a complaint filed by the franchisee’s employees against the franchisor where the employees argued that the franchisor was, for purposes of the federal Fair Labor Standards Act (“FLSA”), their employer.

Determining who is an employer under the FLSA can be tricky and may depend on which circuit the case is brought.  A recent Fifth Circuit case may give some hope to franchisors.  In Orozco v. Plackis [PDF], No. 13-50632 (5th Cir. 2014), the Fifth Circuit Court of Appeals reversed a jury verdict and award for damages for violations of the FLSA entered against the franchisor and in favor of the franchisee’s former employer.

The Court used the “economic realities” test to determine if the franchisor could be a joint with the franchisee.  In holding that the franchisor was not an employer for FLSA purposes, the Court noted that the franchisor did not have the power to hire or fire the franchisee’s employees nor did the franchisor have control over the terms and conditions of the worker’s employment.

The interesting part of the decision for franchisors is that there was some evidence that the franchisor did provide advice to the franchisee which seemed to include a meeting where the franchisor advised how to reduce payroll through better scheduling. Immediately after this meeting, the franchisee changed the plaintiff’s schedule which is what led to the complaint.

The Court noted that it would expect franchisors to provide some advice to a struggling franchisee but providing this advice did not mean that the franchisor had control over the terms and conditions of the franchisee’s employees.   The key to this decision is that the evidence demonstrated that the advice provided by the franchisor was just that, advice, meaning it could either be taken or ignored by the franchisee.

However, franchisors should remain cautious when venturing into areas such as their franchisees’ workers schedules and salaries to be paid. Even friendly advice given often enough might be perceived by courts or jurors as mandatory rather than optional.

Best Practices to Avoid Hackers: Must Read for Franchisors and Franchisees

Posted in Business Updates, Industry Updates

Entrepreneur this week released its “Best Practices for Employees to Protect the Company From Hackers”. The article contains some great tips for franchise businesses to implement for avoiding data breaches through employee conduct.   This is critically helpful information during a time where major data breaches seem to pop up on the news every day.

So many articles discuss what businesses should do from a high level management perspective focusing on implementing sophisticated changes to technology, data collection and storage policies and practices.  In this article, however, the writer, Dick Anderson, focuses on what EMPLOYEES should do to protect themselves and their employers.

Mr. Anderson opens with a description of phishing exercises he conducts for clients where results show that 70% or more employees will follow a link to a bogus site and of those that follow the link, 30-50% give up their usernames and passwords!

Many of the tips should be common sense to most people such as making sure that employees are not using work computers for personal business and keeping browsers, and plug-ins (such as Adobe Flash or Java) updated.  The article also contains some lesser known recommendations and provides a blunt and honest look at how employees are an easy target for hackers looking to get past a company’s security controls.

To read the entire article on Entrepreneur.com, you can click here.

Get Your New ACA (aka Obamacare) Guidance Right Here

Posted in Regulatory Compliance

In its continuing efforts to provide guidance on the twice-delayed Patient Protection and Affordable Care Act (PPACA) provisions, the Obama administration released guidance last Thursday and draft forms instructing employers how to comply with the employer mandate under the PPACA. The 13-page draft instructions are posted on the IRS website.

Past delays in guidance has raised concerns that the employer mandate would be delayed a third time. Presently, employers with between 50 and 99 employees have until January 2016 to offer health insurance or pay and fine, and employers with over 100 employees have until January 2015. Employers with fewer than 50 employees are exempt.

The IRS documents include drafts of forms and related instructions for: Form 1095-A, the Health Insurance Marketplace Statement; Form 1095-B, Health Coverage ; and Form 1095-C, Employer Provided Health Insurance Offer and Coverage.

 

Vicarious Liability: Can We Breathe a Sigh of Relief after Patterson? (No)

Posted in Legal Decisions

It hasn’t been a great summer for the issue of vicarious liability in franchising. In particular, the Office of General Counsel of the NLRB, in its McDonald’s recommendation, has demonstrated that it is hostile to the franchising model of business. So many of us were rightly concerned about how the California Supreme Court would rule in Patterson v. Domino’s Pizza, LLC. [PDF].

The facts of the case are terribly unfortunate. Taylor Patterson obtained a job at a local Domino’s franchise in Southern California owned by a company called Sui Juris, LLC. Ms. Patterson alleged that a shift manager sexually harassed her whenever she and he shared the same shift. We can all agree that the alleged conduct was outrageous. Ms. Patterson claimed that the manager made lewd comments, and grabbed her breasts and buttocks. When the manager refused to stop, Ms. Patterson reported the conduct to the owner of Sui Juris and her father. She stayed away from work for one week. When she returned, she perceived that her hours had been cut in retaliation for reporting the harassment.

30014105_sPatterson’s father called a 1-800 customer complaint line set up by Domino’s and reported what had happened to his daughter. In this manner, one of the key factual issues in the case developed. As a result of that call, the information was passed to a Domino’s “area leader” for over 100 franchisees in Southern California. In discussing what had happened to Patterson with the franchise owner, the area leader allegedly told the owner, “You’ve got [to] get rid of this guy.” Importantly, the franchise owner testified that he saw no specific implication in the remarks of his area leader nor did he ask what would happen if he didn’t fire the manager. Ultimately, the manager stopped showing up for work, resolving the issue in the mind of the owner.

Nonetheless, the area leader’s statement became a significant issue in the case after Ms. Patterson sued, naming not just the franchisee but the franchisor as well. Domino’s sought summary judgment, stating that it was not an employer or principal of the manager, and that it could not be held vicariously liable as a result. The trial court agreed, but then the Court of Appeal reversed, holding that there was a triable issue of fact as to whether Domino’s was an employer or principal for vicarious liability purposes. The Court of Appeal seemed to give particular weight to the “get rid of this guy” statements of the area leader, along with the franchisee’s testimony that he followed her instructions.

The Supreme Court, after a careful and nuanced review of the franchising business model and vicarious liability law involving franchise systems, concluded that the trial court had been correct; Domino’s was not the employer or principal of the manager who committed the harassment of Ms. Patterson. The Court focused on the means and manner test: an agency relationship exists only where the principal dictates, not just the desired result of the enterprise, but also the manner and means by which the result is achieved. The Court held that a comprehensive operating system alone does not constitute the amount of control necessary to support vicarious liability claims like those raised by Ms. Patterson.

With respect to personnel issues, the Court found that Domino’s franchisees are owner-operators who hire and train the people who work for them, and who oversee the performance of those employees every day. In fact, in this Court’s view, a franchisor only becomes potentially liable for the actions of the franchisee’s employees if it retains or assumes a general right of control over factors such as hiring, direction, supervision, discipline, discharge and relevant day-to-day aspects of the franchisee workplace. Moreover, in reviewing the evidence, the Court found that Domino’s had no contractual authority to manage the behavior of employees and, in fact, that it did not have any such actual authority either. Domino’s was not involved in the application, review or hiring processes of its franchisees.  The franchisee was also solely responsible for training employees on how to treat each other at work and how to avoid sexual harassment.

So, a win for franchising? In the immediate term, yes. But I see significant potential long-term issues with the Supreme Court’s opinion. First, the Court essentially authored a roadmap for lawyers looking for ways to sue franchise systems on grounds of vicarious liability. Franchisors should take a hard look at their systems, training programs and operating manuals–particularly if they are operating in California–to absolutely ensure that they do not control the manner and means where agency could be an issue.  Second, training of regional representatives, area leaders, and the like should emphasize that business areas left to the franchisee’s control must be left to the franchisee’s control. While the majority opinion accepted the testimony of the franchisee that he saw no implication in the “get rid of this guy” statement, the Court of Appeals and especially the dissenters on the Supreme Court seized on this comment. Unless it is truly a branding matter, it is best that the franchisor’s representative stay out of the fray.

And that brings me to the third and most troubling issue. The dissenters, who would have found vicarious liability, pointed to the fact that the Domino’s area leader once told the franchisee in this case to have a manager stop using Domino’s-branded bags to deliver a competitor’s food as further evidence of Domino’s control over personnel decisions. Huh? That’s right: what seems like a clear branding matter to a franchise professional is a personnel issue to three members of the California Supreme Court. Now, let me add that the Supreme Court decision was 4 to 3. One person changes sides, and this is a completely different (and very troubling) decision.